Category ►►► Toxic Jackassets

January 3, 2010

Ben Bernanke: Ignoramus - or Politician?

So the allegedly smartest financial guy in the world hath spoken on the housing-finance crisis. He spake at length; if you want to readeth the entire brain-numbing speech, here it be.

He spoke of the various factors (notably monetary policy) that could have led (but didn't) to the housing bubble, the collapse of which is largely responsible for the worldwide recession that technically began in the fourth quarter of 2008. And he issued his pronouncements about what actually did cause the bubble -- which in Bernanke's mind was an insufficiency of federal regulation, or at least "smart" regulation, from the Federal Reserve. (Shockingly, being its chairman, his solution is to grant the Fed even greater regulatory power).

In fact, his conclusion can be summed up in a single sentence: Some critics say the housing crisis was caused by the government not regulating money tightly enough; but in reality, it was caused by the government allowing too much Capitalism to occur.

Bernanke does touch -- very briefly! -- on the faint possibility that "exotic mortgages" with "exotic features" might have contributed to the problem (I suspect "exotic" is a buzz word in financial circles). But nowhere does he even so much as mention what nearly every conservative, libertarian, Capitalist, or at least independent economist and financial analyst long since concluded was the real culprit in the housing bubble: For more than three decades, Congress forced banks to lend trillions in sweetheart loans to poor people who couldn't afford them.

As Peter Schweizer amply demonstrates in his seminal book Architects of Ruin -- required reading for everybody who cares about the American economy (I doubt Bernanke is even aware of the book's existence) -- radical housing activists used race-baiting and the court system, aided by ultra-liberals in Congress and in particular by Presidents Jimmy Carter, Bill Clinton, and Barack H. Obama, to force an ever increasing percentage of mortagages to flow to people without any means to pay them... on the radical socialist theory that home-ownership is a human right. (For "the right to home ownership" read "the right to buy a five-room mansion on a studio apartment income.")

Banks and S&Ls were threatened into making unrecoverable loans by the very regulatory agencies that should have forced them to be more fiscally responsible (or at least marginally sane). They saw their mergers held up, their expansions frozen, their federal contracts suspended... until they agreed to create "exotic" home loans (such as interest-only, adjustable-rate mortgages) to, in essence, give everybody a house, whether he could afford it or not.

To keep the financial institutions afloat, radicals "reformed" the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac (for "reformed" read "turned on their heads"); henceforth, instead of setting a high standard for the loans they would back, requiring good credit, a clean personal history, a steady job, and an adequate income -- thus encouraging private financial institutions to do the same, lest their loans be ineligible for purchase by Fannie and Freddie -- the GSEs instead lowered and lowered the standards, like a game of financial "limbo," encouraging their clients, the banks, to do the same. And "Limbo" is right where they ended, holding trillions and trillions of dollars of toxic "assets," whose value, when it could be calculated at all, was about equal to the paper and ink used to print them.

Although Fannie and Freddie were supposedly private companies that theoretically could go bankrupt from such psychotic policies, everyone assumed (accurately, as it turned out) that no matter how many subprime mortgages were purchased by these GSEs, the federal government would ultimately underwrite them all; that is, Fannie and Freddie would bail out the banks, and taxpayers would bail out Fannie and Freddie.

From the introduction to Architects of Ruin:

But the heart of the story is the role that radical activists and liberal politicians in Washington played in trying to harness the U.S. financial system to advance their socialist agenda....

[T]he liberal baby boomers -- born to affluence, burdened by guilt -- saw the capitalist system as inherently flawed and unfair. More important, they saw it as a system that could, and should, be manipulated for "progressive" social purposes. Calll it "do-good capitalism": the merging of sixties social values with the rewards of the profit system. The chief buzzwords of this enlightened form of capitalism are the fashionable notions of socially responsible investing and corporate citizenship.

As the liberal boomers rose to power in the 1970s, '80s, and '90s, they increasingly sought to harness the engine of capitalism to their vision of a good society. Thus, to further their activist goals, liberals in and out of Washington pushed the federal government deeper and deeper into engagement with the housing market, artificially driving the costs of lending down and pumping the system full of toxic debt.

At the same time, liberals in the Clinton administration entered into an unprecedented partnership with the financial industry that amounted to a form of state capitalism. Under Clinton, a series of Wall Street bailouts taught the big financial houses that if they failed, the federal government would come to their rescue.... This only had the effect of further corrupting their judgment, inuring them to risks by insulating them from the ruthless discipline of the market.

However, Ben Bernanke appears not to remember any of this history.

This is especially strange, since in 2007, when Sen. Chuck Schumer (D-NY, 100%) proposed reinflating the housing bubble by forcing Fannie and Freddie to buy another $145 billion of failed loans, it was Chairman of the Federal Reserve Ben Bernanke who strenuously objected. Of course, that was when his boss was George W. Bush, who repeatedly attempted to rein in the "state capitalism" initiated by his predecessor, Bill Clinton, then resurrected by Bush's successor, Barack Obama. What a difference a couple of years, and a change of presidencies, makes in Bernanke's worldview!

And how quaint and precious that Schumer bill seems now, with its paltry $145 billion to buy more toxic debt. On Christmas Eve, the Obamunist announced an Executive Order giving a blank check to Fannie and Freddie: They can now buy more unrecoverable debt through 2012 with no ceiling whatsoever. Fannie and Freddie will likely purchase tends of trillions of dollars more of such toxic assets before the November elections give us a chance to terminate that deal, thus locking in "Obamunism" for the rest of the president's term. As the Wall Street Journal reports:

The Treasury announced Thursday it was removing the caps that limited the amount of available capital to the companies to $200 billion each.

Unlimited access to bailout funds through 2012 was "necessary for preserving the continued strength and stability of the mortgage market," the Treasury said. Fannie and Freddie purchase or guarantee most U.S. home mortgages and have run up huge losses stemming from the worst wave of defaults since the 1930s....

The Treasury removed the cap on the size of available bailout funds by amending agreements it reached with the companies in September 2008, when the government seized control of the agencies under a legal process called conservatorship. The agreement allowed the Treasury to make amendments through the end of the year, without the consent of Congress. Changes made after Dec. 31 would likely involve a struggle with lawmakers over the terms.

Oh, and of course the obligatory hand-buttering:

The companies on Thursday disclosed new packages that will pay Fannie Chief Executive Officer Michael Williams and Freddie CEO Charles Haldeman Jr. as much as $6 million a year, including bonuses. The packages were approved by the Treasury and the Federal Housing Finance Agency, or FHFA, which regulates the companies....

Under the new packages, Fannie will pay as much as about $3.6 million annually to David M. Johnson, chief financial officer; $2.4 million to Kenneth Bacon, who heads a unit that finances apartment buildings; $2.8 million to David Benson, capital markets chief; $2.2 million to David Hisey, deputy chief financial officer; $3 million to Timothy Mayopoulos, general counsel; and $2.8 million to Kenneth Phelan, chief risk officer.

At Freddie, annual compensation will total as much as $4.5 million for Bruce Witherell, chief operating officer; $3.5 million for Ross Kari, chief financial officer; $2.8 million for Robert Bostrom, general counsel; and $2.7 million for Paul George, head of human resources.

The pay deals also drew fire. With unemployment near 10%, "to be handing out $6 million bonuses to essentially federal employees is unconscionable," said Rep. Jeb Hensarling, a Texas Republican who is a frequent critic of Fannie and Freddie.

Not bad for a pair of enterprises at the rim of a financial black hole; but of course, let's not forget these are government-sponsored enterprises, and that makes all the difference. (I assume Fannie and Freddie will also be immune to any executive pay caps imposed by the One the Radicals Have Been Waiting For, in his relentless quest to promote "Robin Hood Capitalism," as Schweizer puts it in Architects of Ruin. After all, Fannie and Freddie are doing "a heck of a job" saving the world from the free market; their execs should be "adequately" compensated.)

What guesses can we hazard about the conclusions that will be drawn over the next few months by Chuck Schumer, Chris Dodd (D-CT, 100%), Barney Frank (D-MA, 100%), Barack Obama, Ben Bernanke, and others running (or ruining) our economy?

The fix for Fannie and Freddie having lent too much money to people with too little to pay it back -- is to lend even more to the same people, so they can buy even bigger houses that they can even less afford.

The proper response to radical socialists ramming fantastical, ideologically based regulation though Congress is to encourage them to redouble their efforts.

The solution to diminished wealth creation due to warping the free-market system into "state capitalism" is to finish the job and dive whole hog into the liberal fascism cesspool.

And the remedial corrective for those who should have been overseeing our financial system, from regulators like Bernanke to journalists at the New York Times and the Washington Post, but who turned the other eye for the most part... is for our overseers to become full-fledged cheerleaders for the very radical policies that have brought the world's mightiest economy to its knees, so that we must beg "friends" like the People's Republic of China to bail us out.

Assuming America survives such economic ruin -- as I do assume, agreeing with Adam Smith "that there is a great deal of ruin in a nation" -- I believe the rise of the Baby Boomers to power as radical "reformers" of Capitalism will come to be seen in hindsight as one of the greatest threats the world has ever known. The "Boomer Bust" is the late twentieth, early twenty-first century echo of the rise of nakedly totalitarian socialism in the late nineteenth and early twentieth. (Much as Sauron was the echo of his master Morgoth in the Lord of the Rings trilogy.)

September 12, 2009

Once Again, Lizards Proven Smarter Than Democrats!

Democratic Culture of Corruption
, Toxic Jackassets

Hatched by Dafydd

Aeons and millennia ago -- almost a year ago, actually -- we published a piece purporting to explain just what had happened to bring the financial heads to their knees. We discussed sub-prime mortages, how they were repackaged into Mortgage Backed Securities (MBSs) and Collateralized Debt Obligations (CDOs) (turning mortgages into bond-like securities), toxic assets, and so forth. This post spawned numerous others, until we had published literally thousands of words on the original "stimulus package" put together by then-Secretary of the Treasury Henry Paulson and (still current) Chairman of the Federal Reserve Ben Bernanke (all right, technically, he's "Chairman of the Board of Governors of the United States Federal Reserve." Is it really that important?)

Why the financial collapse?

So what started as mortgages -- ranging from very secure prime mortgages, which are doing fine, to lousy subprime mortgages for too much money to borrowers who really didn't have either the credit history or income to justify such loans, many of which are currently in default 60 days or more -- were, by the magic of "securitization," turned into bond-like securities; and in the process, many of the bad and even defaulted loans were transmaugrified into AAA-rated investments....

But defaults, of course, are where the whole pyramid scheme broke down. While housing prices continued to rise, everybody was happy and there were few defaults. But starting a couple of years ago, when the housing bubble burst and the mortgage default rate shot up, a bunch of banks found themselves holding very insecure securities, losing money hand over teakettle. The crash began among the lenders and spread to secondary markets (the MBSs and CDOs) and even tertiary markets (insurance underwriters like AIG). In short order, institutions all over the world found themselves holding pieces of paper whose value was impossible to determine -- which are referred to as toxic assets.

Toxic assets are illiquid, meaning they cannot be bought or sold because nobody knows how much to offer for them; they are frozen. If you hang onto them, they might regain some value later... or they could disappear completely. Worse, illiquid securities see their ratings drop; and current law forbids some types of funds from holding anything but AAAs... which means they may be forced by law to sell -- but unable to sell because of illiquidity!

Not only that, but current law also requires that such securities be "marked to market," meaning they must be valued at the last price offered by some institution that was desperate to sell -- because of the law in the previous paragraph. Thus, even institutions that didn't have to sell their toxic assets had to reprice them; this meant that a number of financial institutions suddenly did not have sufficient reserves for the amount of loans or leveraging they had out. That meant they needed to get hard cash and fast... which meant they would have to panic-sell a bunch of securities, precipitating a new round of re-rating and re-valuating.

Eventually, nobody had a clue what anything was worth anymore; and nearly every financial institution in the world, it seems, was involved up to the fourth cervical vertebra in this mess.

We've all been looking at this problem from the wrong perspective: We keep thinking of the rescue plan as injecting liquidity into the banking system and other credit markets; but the real need is to inject, not liquidity, but information; liquidity is just a seredipitous side effect.

The more I read about the current world fiscal crisis, the more I believe that it's not a market failure, not a credit failure, not a mortgage failure, and not a liquidity failure: Those are all symptoms of the real, underlying failure.

What has actually failed is the world information supply. Simply put, everything related to finance, to trade, to buying and selling -- in short, everything connected with any kind of a market -- depends upon access to timely, honest, accurate, and believable information (hereafter "THABI"). For an example I have used before, you cannot buy a car based solely on a grainy picture in a newspaper, because you cannot put a value on it; does it even have an engine?

You need THABI before you can make an offer. And the same is true for mortgages, mortgage-backed securities (MBS), credit default swaps (CDS), construction loans, business letters of credit (LOC), and so forth. Without sufficient THABI, no seller has any idea what price to ask the buyer, and no buyer has any idea what price to offer the seller. Buyers and sellers cannot come to a "meeting of minds," which means nobody can agree on any contract. And that means no market can exist.

That is exactly what has happened and is still happening today, all around the world: a global shortage of THABI, of timely, honest, accurate, and believable information.

So the problem was that nobody knew how to evaluate those Mortgage Backed Securities (MBSs), because we had a catastrophic and entirely artificial dearth of THABI -- "timely, honest, accurate, and believable information" -- about those MBSs and related securitized mortgages: They could not be valuated because we didn't have a clue what they were really worth.

Therefore, financial institutions didn't know what their own investments were worth, either. They had no idea how much reserves they had, so they had to panic-sell a bunch of their securities to remain within the law. And the feds' insistance on "mark to market" didn't help, since it forced institutions to immediately value their holdings on the basis of the lowest recent bid, even if that meant they valued them far below their actual worth.

Under such circumstances, a free market is impossible. It's as if there were no medium of exchange; how could you buy anything if there were no currency -- or at least, if nobody could agree on the value of a dollar?

Enter Paulson-Bernanke

That was the reason for the original "stimulus" package. It was originally intended to inject, not liquidity, but information into the market. From Democrats Try to Hijack:

So what is to be done? Obviously, since the problem is the inability to set a value for these instruments, which makes them impossible to buy or sell (illiquid), the solution is to find a way to value them. Enter the Paulson-Bernanke emergency rescue plan....

As I understand it, here is the basic plan. Note that I'm drawing this from many sources, it's not yet written in stone -- or even in ink -- and I can't give you sources. If you want more information, you're on your own! But here is what I've been able to glean:

The Treasury is given authority to spend up to $700 billion (outstanding at any particular moment) to buy MBSs, CDOs, and related instruments that have become "illiquid." These "toxic assets" will be purchased from their current owners at a huge discount... meaning the banks and other investors who purchased these pigs in pokes will, in fact, take a significant financial hit... they're not being "bailed out."

So the Treasury can buy up these toxic assets; what do they do with them?

I believe the plan (which has not yet been formalized in legislation) is to create a Treasury owned and managed resolution corporation that will take ownership of these toxic assets. Analysts will then pore through each MBS, determining the status of all the underlying mortgages and making a report publicly available. This will make the opaque assets completely transparent. All the financial fundamentals will be visible, so analysts at private companies can examine all of the securities and decide how much they would pay for each.

The resolution corporation will then auction off each of the the now-transparent MBSs, selling it to the highest bidder; that very action allows the market to reset the value of the security.

That is why I characterize this rescue operation as "pressing the reset button."

HouseGOPs stick in their two cents worth (and that's overvaluing it!)

Then the House Republicans got into the act. They didn't like the idea of Treasury buying toxic assets, so they added one step in between: That the federal government would first try "insuring" the toxics, to see whether that would give them a sufficient base value that they could be valuated by the free market. From the Done Deal - at Least, Very Likely Done:

As we predicted, it is basically the original deal with some of the HRs' proposals rolled in... notably the insurance option, which would be one of the choices that Secretary Henry Paulson has at his disposal and is required to set up and at least attempt before buying the toxic assets on behalf of the government:

At the insistence of House Republicans, who threatened to sidetrack negotiations at midweek, the insurance provision was added as an alternative to having the government buy distressed securities. House Republicans say it will require less taxpayer spending for the bailout.

But the Treasury Department has said the insurance provision would not pump enough money into the financial sector to make credit sufficiently available. The department would decide how to structure the insurance provisions, said Sen. Kent Conrad, D-N.D., one of the negotiators.

The final cut: equity stakes in banks

However, the collapse accelerated much more rapidly than expected before the Paulson-Bernanke emergency rescue plan could be implemented, and they decided they needed to inject liquidity directly into the financial institutions. From Is It Adios:

As the market is unable to function without THABI, it cannot function to restore THABI. All that information must come from somewhere else; and the only "somewhere else" that can act quickly enough to stave off a global depression is the State. Because the State functions both within and without the market, it can force changes even when the market is stymied... just as it takes a State to enforce the decisions of a civil-court, because only the State can step outside the market to seize by force the bank accounts of those who flout the court's decision.

The direct injection of liquidity by Treasury buying equity is also outside the market, because that money is extracted from people by force, in the form of taxes. But at the core, even this direct investment is an attempt to buy time to complete the "transparentizing" (horrible neologism, I know) of the toxic assets -- the recreation of the information that was lost by multiple unregulated securitizations of massive collections of mortgages.

Once the THABI has been restored to the mortgage-backed securities and other instruments, the market can reboot itself:

The assets can be valued;

They will all have some nonzero value, because no mortgage is worth nothing (if nothing else, the land itself has value);

All will be saleable, though often not at as high a price as the financial institution purchased them;

Each institution will thus be able to figure out how big a write-down it must take... and whether it can even stay in business or needs to sell itself to another institution.

There... that's a market! With the restoration of the missing THABI information, the market can reboot, and the catastrophe will be averted. So long as partial-nationalization of the banking industry lasts only long enough to retransparentize the toxic assets, thus allowing the market to begin functioning again, it will be an acceptable, even necessary intervention.

Alas, I then made an implied prediction that did not come true:

Bush and Paulson have really worked hard to make it difficult for a future president to use this plan as the camel's nose poking its way under the big top; the plan is designed to sunset automatically, allowing the banks to buy back their equity in no longer than three years, but earlier if both they and the incoming administration agree.

When people read "fascism," they immediately tend to envision concentration camps, jackboots, and Nazis goosestepping at mass rallies; but the real danger of fascism, especially liberal fascism (fascism with a smiley face, as depicted -- against author Jonah Goldberg's wishes -- on the cover of his book Liberal Fascism), is government control of corporations. The more control is handed over to politicians and bureaucrats who have no hand in actually producing the product (loans and securities, in this case), the more critical decisions will be made on irrelevant political considerations, often leading to financial disaster... and another bailout, leading to even more government control. Eventually, the State completely hijacks the corporation for political purposes... and we're well on our way to Hugo Chavez-land.

Why am I recapping this stream of previous Lizardry? Well, take a look at Thursday's story from Cybercast News Service:

A report issued by the Congressional Oversight Panel (COP) tasked with overseeing the implementation of the 2008 Troubled Asset Relief Program (TARP) questions whether the Bush and Obama administrations had the legal authority to use TARP funds to bail out General Motors and Chrysler.

The report, issued Wednesday, confirmed what CNSNews.com had previously reported: that the law which created TARP -- the Emergency Economic Stabilization Act (EESA) -- did not grant the government specific authority to use taxpayers’ funds to rescue the auto industry.

In other words, we're blowing our own forked tongues here: The original stimulus plan, the original Paulson-Bernanke plan, would have restricted that $700 billion to buying toxic assets; the later House Republican version would have also allowed funds to be used to insure toxic assets. And the final Paulson-Bernanke plan would also include using the money to buy equity stakes in the financial institutions themselves, in order to inject liquidity directly.

But under Barack Obama, the government appears to have criminally abused the stimulus bill to buy General Motors and Chrysler stock -- which has absolutely nothing to do with injecting liquidity into the financial markets to stave off collapse... and everything to do with bailing out the auto manufacturers to benefit the United Auto Workers.

So once again, it turns out that Big Lizards was either smarter than the Democrats (in figuring out what we needed to so) -- or at the very least, more honest than the Democrats.

March 23, 2009

Déjà Vu About Vujà Dé

I once crafted a neologism, vujà dé, bouncing off of the psychological term déjà vu -- the false feeling that something you are now experiencing happened before. My new word vujà dé means -- the false feeling that something that actually happened before is really brand, spanking new!

I woke up this morning -- well, this afternoon -- and read the following new financial-rescue plan from Treasury Secretary Tim Geithner:

The Obama administration formally presented the latest step in its financial rescue package on Monday, an attempt to draw private investors into partnership with a new federal entity that could eventually buy up to $1 trillion in troubled assets that are weighing down banks and clogging up the credit markets....

Initially, a new Public-Private Investment Program will provide financing for $500 billion in purchasing power to buy those troubled or toxic assets -- which the government refers to more diplomatically as legacy assets -- with the potential of expanding later to as much as $1 trillion, according to a fact sheet issued by the Treasury Department.

At the core of the financing package will be $75 billion to $100 billion in capital from the existing financial bailout known as TARP, the Troubled Assets Relief Program, along with the share provided by private investors, which the government hopes will come to 5 percent or more. By leveraging this program through the Federal Deposit Insurance Corporation and the Federal Reserve, huge amounts of bad loans can be acquired.

The private investors would be subsidized but could stand to lose their investments, while the taxpayers could share in prospective profits as the assets are eventually sold, the Treasury said. The administration said that it expected participation from pension funds, insurance companies and other long-term investors.

This gave me an intense feeling of déjà vu (not vujà dé); didn't... we... see something like this sometime before? Not very long ago? Something... something... it's all coming back to me now....

As proposed by Secretary of the Treasury Henry Paulson and Chairman of the Federal Reserve Ben Bernanke, the putative "$700 billion" "bailout" is actually neither: It will neither cost that much, nor will it bail out those financial institutions that wrote bad loans for people they knew were not likely to be able to pay them off.

As I understand it, here is the basic plan. Note that I'm drawing this from many sources, it's not yet written in stone -- or even in ink -- and I can't give you sources. If you want more information, you're on your own! But here is what I've been able to glean:

The Treasury is given authority to spend up to $700 billion (outstanding at any particular moment) to buy MBSs, CDOs, and related instruments that have become "illiquid." These "toxic assets" will be purchased from their current owners at a huge discount... meaning the banks and other investors who purchased these pigs in pokes will, in fact, take a significant financial hit... they're not being "bailed out."

So the Treasury can buy up these toxic assets; what do they do with them?

I believe the plan (which has not yet been formalized in legislation) is to create a Treasury owned and managed resolution corporation that will take ownership of these toxic assets. Analysts will then pore through each MBS, determining the status of all the underlying mortgages and making a report publicly available. This will make the opaque assets completely transparent. All the financial fundamentals will be visible, so analysts at private companies can examine all of the securities and decide how much they would pay for each.

The resolution corporation will then auction off each of the the now-transparent MBSs, selling it to the highest bidder; that very action allows the market to reset the value of the security.

That is why I characterize this rescue operation as "pressing the reset button."

Once some corporation has examined the fundamentals of the security and offered the winning bid for it, the MBS becomes (by definition) liquid; it is no longer a toxic asset. Its value has been reset... and it can go up or down after that point based upon subsequent, well-understood events (defaults, repayments, prepayments) in the underlying mortgages and reevaluations based upon other, market-based criteria. In other words, it becomes just like a mutual fund.

The crisis was the inability to value MBSs; the solution is to reset their values. The beauty of the Paulson-Bernanke plan is that this resetting is done by the free market, not by government decree.

Finally, note this point:

When the Treasury-owned resolution corporation auctions off the now-transparent MBSs, it can use that money as income. Since the asset is now much more valuable than before (having been scrubbed into transparency), if it becomes saleable, then it will certainly sell for more than the discounted rate at which the corporation bought it. In other words, the resolution corporation will make a profit on every security it resells -- so the program will not actually cost $700 billion... it may even end up completely in the black.

That's why the Paulson-Bernanke plan is neither a bailout -- the so-called beneficiaries in fact must pay dearly for their folly -- nor massively expensive, since it resells most of the securities it bought, and at a profit. It could still end up costing money, depending on how many of the MBSs end up still toxic even after the complete report (if too many of the underlying mortgages are in default, for example); but the losses won't be anywhere near $700 billion, and they may be less than the profits.

That was a Big Lizards post from September 22nd, 2008; the differences between the old plan, from almost exactly six months ago -- developed by George W. Bush's Treasury Secretary Hank Paulson and then Chairman of the Federal Reserve Ben Bernanke -- and the new plan just proposed today by Barack H. Obama's Treasury Secretary Tim Geithner and current Chairman of the Federal Reserve Ben Bernanke are... well, subtle:

The Paulson-Bernanke plan wasn't quite as expensive as the Geither-Bernanke plan;

It didn't have the patina of private investors coming along for the ride (heavily subsidized by the federal government and leveraged by the Federal Deposit Insurance Corporation, FDIC) that we see in today's version;

In the original version, the government would buy the toxic assets from their current owners at a discount; Treasury (or a Treasury-owned resolution corporation) would investigate and "valuate" them (determine the actual value of the underlying mortgages that make up each mortgage-backed security, MBS, and related debt instrument); and then private investors would buy the formerly toxic, now liquid assets from the government at an auction. In the new version, the government will partner with private and corporate investors, leveraged by the FDIC, to buy the assets; then they would be auctioned to other private and corporate investors.

I don't know about you all, but the distinction between the two plans doesn't leap off the screen for me. The Times doesn't report whether the feds will undertake the intermediate step of investigating and reporting the details of these toxic assets, but I think it must be so; I can't see how else could they be turned from illiquid to liquid, except by injection of what I called in a later post, "timely, honest, accurate, and believable information," or THABI.

It seems I wasn't suffering from déjà vu after all. As the great sage Bert the one-man band, sidewalk chalk artist, and chimney sweep said, "Can't put me finger on what lies in store, but I feel what's to happen all happened before."

The current plan even includes the reset-by-auction of toxic assets that I gleaned from the original plan; from the Times story above:

An attractive feature of the program is that it will allow the marketplace to establish values for the assets -- based, of course, on the auction mechanism that will signal what someone is willing to pay for them -- and thus might ease the virtual paralysis that has surrounded those assets up to now.

For a relatively small equity exposure, the private investor thus stands to make a considerable return if prices recover. The government will make a gain as well. In the worst case, the bulk of the risk would fall on the government. The presumption, of course, is that the auction will lead to realistic purchase prices.

So where does vujà dé (not déjà vu) enter into it? Simply this: I haven't seen a single elite-media commenter point out that this is the very same plan we started with... lo these many months ago; the same plan that was quickly derided by congressional Democrats, railed against by presidential-candidate Barack Obama, dismissed as nonsense by voters (and by Wall Street), and derailed in favor of direct investments in -- that is, nationalization of -- banks, savings and loans, insurance companies like AIG, and so forth.

Everyone writes and speaks as though this is a brilliant innovation -- imagine, buying up toxic assets and using public auctions to establish a "realistic purchase price" for them! Who but Geithner could possibly have thought of such a corker of a solution? He's finally demonstrated the mental superiority with which he was hailed when he was nominated (so brilliant, we simply had to overlook that little kerfuffle about evading income taxes when he worked at the International Monetary Fund).

I still have a few questions:

How long will the elite media continue to heap scorn upon that fool, Henry Paulson, and his ludicrous plan to buy up toxic assets -- while lavishing praise upon that genius, Tim Geithner, for his fantabulous plan to buy up toxic assets?

And what about the hundreds of billions (or is it over a trillion? I can't remember) already spent or pledged by the federal government to buy "equity interests" in hundreds of financial corporations? Do we perpetuate the mass nationalization program even as Treasury crows that the wonderful thing about the new rescue plan is that it privatizes the bailout?

Does the Obama White House suffer from Multiple Ideology Syndrome?

Everything old is new again, the wheel has come full circle, and what a long, strange trip it's been!

Obama's State-Ownership Society

Back in the precambrian era -- in fall of 2008, I of course mean -- we warned in several posts that when the federal government takes an "equity interest" (ownership in whole or in significant part) in private companies, it creates a grave threat to the capitalist system:

When government buys a significant stake in private companies, it creates a terrible conflict of interest; decisions that should be made entirely on economic grounds -- attempting to maximize the long-term profit for the owners of the company, whether stockholders or private consortia -- are made instead by politicians pushing a particular political ideology, or else trying to benefit big campaign donors.

Corporate management is ultimately accountable to the owners (though owners can be derelict in their fiduciary duties), while politicians are accountable only to voters and donors, neither of which may have any particular concern about the financial viability of particular private companies in the government's stock portfolio.

This is how we explained it in the first post linked above:

The latter especially is a key element of Woodrow Wilson, Benito Mussolini style fascism; it invariably leads to the State, as the $700 billion gorilla on the board of directors, exerting overwhelming control over corporate decisions... which it will exercise on the basis of politics, not profits.

When people read "fascism," they immediately tend to envision concentration camps, jackboots, and Nazis goosestepping at mass rallies; but the real danger of fascism, especially liberal fascism (fascism with a smiley face, as depicted -- against author Jonah Goldberg's wishes -- on the cover of his book Liberal Fascism), is government control of corporations. The more control is handed over to politicians and bureaucrats who have no hand in actually producing the product (loans and securities, in this case), the more critical decisions will be made on irrelevant political considerations, often leading to financial disaster... and another bailout, leading to even more government control. Eventually, the State completely hijacks the corporation for political purposes... and we're well on our way to Hugo Chavez-land.

The threat posed by the government taking an equity interest in private companies can be minimized by making it a matter of law that the holdings are fully divested as soon as buyers can be found at market prices -- either the company buying back its own stock or private third parties taking it off government's hands; in the third Big Lizards post linked up top, "Is It Adios to Capitalism - or Only Au Revoir?", we discussed this possibility:

With the long-expected decision today by President George W. Bush, Treasury Secretary Henry Paulson, and Fed Chief Ben Bernanke that Treasury will spend $250 billion of the $700 billion buying equity stakes in nine top banks, thus injecting "liquidity" directly into the industry, we stand at a crossroads. The question is whether this is "goodbye" to Capitalism or just "see you soon"... whether this is a permanent break from free markets or just a necessary but temporary bank holiday....

The direct injection of liquidity by Treasury buying equity is also outside the market, because that money is extracted from people by force, in the form of taxes. But at the core, even this direct investment is an attempt to buy time to complete the "transparentizing" (horrible neologism, I know) of the toxic assets -- the recreation of the information that was lost by multiple unregulated securitizations of massive collections of mortgages.

Once the [timely, honest, accurate, and believable information] has been restored to the mortgage-backed securities and other instruments, the market can reboot itself...

With the restoration of the missing THABI information, the market can reboot, and the catastrophe will be averted. So long as partial-nationalization of the banking industry lasts only long enough to retransparentize the toxic assets, thus allowing the market to begin functioning again, it will be an acceptable, even necessary intervention.

Alas, there is nothing in the Obama administration's bailout that implies they will, in fact, consider this a temporary expedient; from everything I've read, they see it as a permanent "reform."

There are two classic anti-capitalist examples of divesting funds for political reasons; together, they point out the very real danger when government becomes a part owner of the private sector through enforced or distressed nationalization (we have seen both in the present crisis):

When universities, big corporations, and of course government programs in the 1970s dumped all their investments in companies based in South Africa or doing business in South Africa, even if they were based elsewhere, to protest Apartheid; this was in response to purely political pressure from black activist groups here in the United States.

And when the usual suspects more recently dumped all investment in Israel, Israeli companies, or companies that did not ritually denounce Israel, in response to purely political pressure from antisemitic, anti-Israel, and generally pro-Palestinian and Islamist activist groups.

Both are examples of government trying to use equity ownership to bully the private sector into purely political actions that have nothing whatsoever to do with the companies in question.

When the government is a significant investor in a company, it cannot help running those companies; government funds never come "string free." Worse, the State runs those companies not to make profits, but to score political points.

In fact, that is exactly what is happening in the case of American International Group (AIG): We have such a huge investment in that company now, $80 billion, that how much they pay employees in retention "bonuses" (inducements to continue working for AIG, rather than jumping ship to some less shaky company) has become a political football.

In fact, the U.S. House of Representatives has just voted overwhelmingly, 328 to 93, to enact a confiscatory tax on AIG employees -- almost by name! -- if AIG fulfills its contractual obligations by paying the employees who stayed on for the work they did (reducing AIG's liability from $2.7 trillion to $1.6 trillion):

Spurred on by a tidal wave of public anger over bonuses paid to executives of the foundering American International Group, the House voted 328 to 93 on Thursday to get back most of the money by levying a 90 percent tax on it....

But there was no doubt after the House vote that the lawmakers were keenly aware of their constituents’ anger, which was focused on A.I.G., although the House measure would apply to executives of any company getting more than $5 billion in federal bailout money.

Hours after the vote, the office of Andrew M. Cuomo, the New York attorney general, said A.I.G. had turned over the names of employees who received bonuses, in response to a subpoena.

Before releasing the list, the attorney general’s office plans to review it and assess whether individuals on it might have reason to fear for their safety.

“We are aware of the security concerns of A.I.G. employees, and we will be sensitive to those issues by doing a risk assessment before releasing any individual’s name,” Mr. Cuomo’s office said in a statement.

Well that's mighty decent of them.

So the bill was openly and unabashedly driven by constituent anger -- anger that cannot possibly be based upon a sober and detailed consideration of whether those particular employees deserved those particular bonuses; in fact, the most likely culprit in ginning up such rage and fury is Congress itself, along with the president, who have been demonizing AIG and its employees for months now. It happened again in the debate on this very bill:

“The people have said ‘no,’ ” Representative Earl Pomeroy, Democrat of North Dakota, shouted on the House floor. “In fact, they said ‘hell no, and give us our money back.’ ”

“Have the recipients of these checks no shame at all?” Mr. Pomeroy continued. Summing up his personal view of the so-far anonymous A.I.G. executives, he said: “You are disgraced professional losers. And by the way, give us our money back.”

Great leaping horny toads. I had to wipe spittle-spray off my face after just reading it! "Disgraced professional losers?" Is Earl "Elmer Gantry" Pomeroy (D-ND, 85%) under the impression that these bonuses are going to the actual folks in the credit default swap area, who are the ones who brought AIG down? Or is Pomeroy just blindly striking out against anyone who makes more money than he?

And while we're on the subject, I think there is not a single Democrat in Congress to whom I could not say, “You are disgraced professional losers; and by the way, give us our money back.” And with a damn sight more justification, Earl.

Contrariwise, John Hinderaker -- my favorite blogger on my favorite blogsite, Power Line -- makes a compelling case that the bonuses were in fact perfectly proper:

They were retention bonuses, not performance bonuses.

They were paid, not to the employees responsible for the collapse, but to other employees who have worked hard for months after the collapse to rescue AIG... rather than jumping ship with their expert knowledge of AIG's exact portfolio problems, taking jobs with other companies that had better futures.

As John writes, "[the employees] satisfied the terms of the bonus by wrapping up a portfolio for which they were responsible and/or staying on the job until now. As a result of the efforts of this group, AIG's financial products exposure is down from $2.7 trillion to $1.6 trillion.

They stayed at AIG precisely because of those bonuses; but now the government, having eaten the fruit of that labor as an equity holder, wants those bonuses to go, not to the people who earned it, but to the government itself!

But note how carefully the Times dances around the question of who exactly is getting the bonuses, and what those people's roles were in the collapse:

The $165 million in bonuses has spawned rage in part because it was paid to executives in the very unit of A.I.G. that arguably turned a stable, prosperous insurance company into a dice-rolling financial firm in search of quick profits.

But there must have been hundreds of employees working in the financial products division! Does the Times think that every employee, from vice president down to secretary, was personally responsible for the foolish decisions that nearly killed AIG? Do liberals fantasize even that every executive in that division was responsible?

If new (post-collapse) AIG CEO Edward Liddy is telling the truth, and so far no current or former employee has come forth to contradict him, then the bonuses are going to people who were not responsible for the collapse, but are responsible for helping AIG deal with the collapse after the fact.

These are the people that Rep. Barney Frank (D-MA, 100%) calls corrupt:

Representative Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee and has been among A.I.G.’s fiercest critics, spoke contemptuously of the bonus recipients as people “who had to be bribed not to abandon the company” they had nearly ruined.

Wouldn't that same language, "bribed not to abandon the company," apply to every employee who ever demanded a raise?

It's another example of liberals' inability to deal with complexity; for all their protestations of having more subtle minds, they are really quite simplistic: The poor (and the rich who "represent" them) are always good; the productive core are always bad; and every moral question is the same shade of neutral gray.

John makes the same point as we anent this ridiculous 90% "tax," which is actually a deliberate attempt at confiscation, as the president made clear yesterday in Orange County. John writes:

The legislation introduced by the Democrats today to tax these bonuses (and possibly a few others, although it isn't clear that any others have been or will be paid that are covered by the statute) at a 90 percent rate is an outrage. It is, in my legal opinion, obviously unconstitutional. It is evidently intended to calm the current political firestorm and not to achieve any real objective.

John refers to the legislation as "introduced by the Democrats;" while that's technically true, it's only a half-truth: Democrats may have proposed it, but the House GOP split almost 50-50 on what Hinderaker (a lawyer) and I (a "sea-lawyer") see as an obvious bill of attainder.

In fact, the AP version of the Times article demonstrates Republican cowardice in the House: 87 Republicans voted against the "tax"; but 85 Republicans voted with the Democrats, blaming those retained employees for all of our woes... most switching at the last minute:

Minority Leader John Boehner, R-Ohio, said the bill was "a political circus" diverting attention from why the administration hadn't done more to block the bonuses before they were paid.

However, although a number of Republicans cast "no" votes against the measure at first, there was a heavy GOP migration to the "yes" side in the closing moments.

This is out and out pandering by the GOP... and it's vile. If we cannot even count on the House Republicans to stand up to liberal demagoguery, to stand up for Capitalism, then what is the point?

It's time for Minority Leader Boehner (R-OH, 100%) to fish or get off the pot: Does he lead a party that is distinct from the liberal Democratic majority, that is center-right, and that still believes in Capitalism, the rule of law, and conservative principles of governance? Has he learned the lessons of 2006 and 2008? Or does Boehner believe that the GOP's best shot at returning to power is to morph into a quieter, gentler version of the Democratic Party, pushing a slightly more restrained version of Obamunism?

I'd really like to know the answer to that conundrum before the next election.

December 5, 2008

Knicks & Knacks I

The Juice gets squeezed

So Orenthal Simpson gets sentenced to a minimum of 15 years, maximum of 33 years, and not eligible for parole until at least nine years have passed. Picture me doing the Snoopy dance all about the room.

Is there any part of Simpson, any slight shred of conscience left, that whispers in his ear that he deserves the sentence he got -- and maybe even more? I sincerely doubt it; I believe he sees himself entirely as the victim here, just as he saw himself as the victim when he murdered his ex-wife, Nicole Brown Simpson, and an innocent witness, Ron Goldman.

I wonder which of the following Simpson has convinced himself of:

That he was completely justified, both in the robbery and in the killings;

That he actually, for real, didn't kill either his former wife or Ron Goldman, and he didn't really rob anybody;

The [House Financial Services] committee chairman, Rep. Barney Frank, D-Mass., cited the jobs report showing the 11th consecutive month of losses as all the more reason for Congress to act to help Detroit.

"For us to do nothing, to allow bankruptcies and failures in one, two or three of these companies in the midst of the worst credit crisis and the worst unemployment situation that we've had in 70 years would be a disaster," Frank said.

Let us rephrase that with some Frank talk of our own:

For us to pound $34 billion worth of sand down the Detroit rathole, without forcing GM, Ford, and Chrysler to radically change their failed business model -- GM has been called "a benefits company that manufactures automobiles as a sideline" -- simply because we can't sit here and "do nothing," would be a folly and a catastrophe of Brobdingnagian stature.

It's a classic example of the "do something" syndrome: Don't stop, don't think, don't wait -- just do something! Of course, sometimes the very best thing to do is sit back patiently and let nature take its course. In this case, if GM and its mini-mes are forced into Chapter 11 bankruptcy, they might actually be able to break some of the onerous labor contracts they've entered into over the decades.

Incidentally, there are two significant differences between the already enacted rescue of Wall Street and the proposed bailout of Detroit; here is the first:

The automakers like to claim that the "American automobile industry" -- by which they mean the American-managed automobile factories in the United States employing American workers and headquartered in the United States, as opposed to the American-managed automobile factories in the United States employing American workers but headquartered in other countries -- "touches" 10% of the American economy.

But the international credit and banking market and the financial industry that controls it is vital to 100% of the American economy. If credit is frozen across the board -- as it was and to some extent still is -- then no company can function. It's a much more significant and national (even international) problem that whether GM goes "bankrupt" and is forced to sell its assets and plants and such to other car companies.

And the second:

In the rescue of the financial markets, we have done two things: At first we purchased "toxic assets," mortgage-backed securities that literally could not be valued, hence could not be traded or used as reserves; then Treasury Secretary Henry Paulson decided to inject money more directly into the financials by buying woefully undervalued stock in major financial companies.

But once we sort out the actual components that make up the MBSes, down to the actual mortgages themselves, they will be found to have an intrinsic, nonzero value: They're based upon real property that has physical value. And once they can be valued, they will be worth more than they are right now. Similarly, as the credit crisis eases, bank stocks will rise.

All of which means that the $700 billion already authorized and any other money spent on this rescue is an investment, not a bailout: We will realize a positive return on our rescue money, especially if lawmakers can find the huevos to repeal or rewrite the laws that currently force financial institutions to offer oversized mortgages to borrowers who cannot possibly make the payments.

By contrast, unless the auto companies can dramatically change their business practices to the point that they can actually compete with Toyote, Honda, BMW, Mercedes, and other "foreign" manufacturers (all made in the United States by American auto workers), they will continue to fail worse and worse, no matter how much money we inject into them.

Even if we gave them their blasted $34 billion bailout, they would simply be back in four years, like Oliver with a twist: Instead of "please sir , I want some more," it will be, "Give us another $50 billion right now, or we'll make the economy collapse again!"

That is the very definition of a bailout: enabling anti-market behavior by shielding companies from the consequences of their own corporate stupidity... hoping that if you just bail enough water out of the boat, the leak will fix itself.

October 14, 2008

Is It Adios to Capitalism - or Only Au Revoir?

Beggar's Banking Banquet
, Toxic Jackassets

Hatched by Dafydd

With the long-expected decision today by President George W. Bush, Treasury Secretary Henry Paulson, and Fed Chief Ben Bernanke that Treasury will spend $250 billion of the $700 billion buying equity stakes in nine top banks, thus injecting "liquidity" directly into the industry, we stand at a crossroads. The question is whether this is "goodbye" to Capitalism or just "see you soon"... whether this is a permanent break from free markets or just a necessary but temporary bank holiday.

I believe Bush when he says it's the latter:

"The government's role will be limited and temporary," Bush pledged. "These measures are not intended to take over the free market but to preserve it. He said these steps and other related actions echoed similar bold moves made overseas in an effort to prevent a global recession. Bush said that by restoring confidence in the system, the hope is to "return our economy back to the road of growth and prosperity."

He said that the efforts to rescue the nation's battered financial sector was a short-term move to help banks to be able to begin lending again.

Alas, it's not up to him, is it? Bush has only three months left in office, and surely this direct-equity program will last longer than that (more likely a year or eighteen months). The question is what the next president will do... whoever he is.

The original plan, recall, was for Treasury to buy (through a resolution corporation) toxic assets themselves; the reason for the change is twofold:

The financial situation deteriorated at warp speed, much faster than expected, and it appeared that the world financial markets were headed towards a Great Depression-level collapse; it seemed to the administration that action had to be taken immediately to inject capital directly into the institutions that otherwise could go under, taking the world economy with them.

It became clear that it was impossible to set up the asset-purchase procedure (including creating a new government-sponsored or owned resolution corporation) quickly enough:

The $700 billion rescue program will continue to feature the purchase by the government of banks' bad assets, but the administration decided to place greater emphasis on the stock purchase program after doubts were raised about how long it might take to get the asset purchase program up and running.

Treasury officials said Tuesday that they still plan to buy troubled assets and that this program would start as soon as possible.

If in fact this turns out to be a temporary nationalization, I don't think it will be that bad. I agree with nearly every economist (though I am not one) that the free market alone cannot resolve this problem; but unlike them, I actually know why, or I think I do. Let me explain why the market is helpless here...

We've all been looking at this problem from the wrong perspective: We keep thinking of the rescue plan as injecting liquidity into the banking system and other credit markets; but the real need is to inject, not liquidity, but information; liquidity is just a seredipitous side effect.

The more I read about the current world fiscal crisis, the more I believe that it's not a market failure, not a credit failure, not a mortgage failure, and not a liquidity failure: Those are all symptoms of the real, underlying failure.

What has actually failed is the world information supply. Simply put, everything related to finance, to trade, to buying and selling -- in short, everything connected with any kind of a market -- depends upon access to timely, honest, accurate, and believable information (hereafter "THABI"). For an example I have used before, you cannot buy a car based solely on a grainy picture in a newspaper, because you cannot put a value on it; does it even have an engine?

You need THABI before you can make an offer. And the same is true for mortgages, mortgage-backed securities (MBS), credit default swaps (CDS), construction loans, business letters of credit (LOC), and so forth. Without sufficient THABI, no seller has any idea what price to ask the buyer, and no buyer has any idea what price to offer the seller. Buyers and sellers cannot come to a "meeting of minds," which means nobody can agree on any contract. And that means no market can exist.

That is exactly what has happened and is still happening today, all around the world: a global shortage of THABI, of timely, honest, accurate, and believable information.

This is caused by the lack of a particular kind of regulation, one that every economist, from Keynesian to libertarian (Austrian or Chicago-school), agrees we need: the THABI requirement. Like a fair, equitable, and trusted civil-court system, access to timely, honest, accurate, and believable information is a fundamental requirement for a market even to exist in the first place. This is why the market cannot itself correct for this problem: THABI is a lower, more fundamental "layer" than the market; the market sits atop THABI. Therefore, in the absence of THABI, the market cannot exist... hence cannot correct for the lack of THABI.

To put it into computer terms, no application software running on a computer can possibly fix the problem of that computer's processor being unable to communicate with the computer's memory: That communication is necessary to run any application at all; clearly you cannot run an application on a computer to fix the problem of being unable to run any application on that same computer.

As the market is unable to function without THABI, it cannot function to restore THABI. All that information must come from somewhere else; and the only "somewhere else" that can act quickly enough to stave off a global depression is the State. Because the State functions both within and without the market, it can force changes even when the market is stymied... just as it takes a State to enforce the decisions of a civil-court, because only the State can step outside the market to seize by force the bank accounts of those who flout the court's decision.

The direct injection of liquidity by Treasury buying equity is also outside the market, because that money is extracted from people by force, in the form of taxes. But at the core, even this direct investment is an attempt to buy time to complete the "transparentizing" (horrible neologism, I know) of the toxic assets -- the recreation of the information that was lost by multiple unregulated securitizations of massive collections of mortgages.

Once the THABI has been restored to the mortgage-backed securities and other instruments, the market can reboot itself:

The assets can be valued;

They will all have some nonzero value, because no mortgage is worth nothing (if nothing else, the land itself has value);

All will be saleable, though often not at as high a price as the financial institution purchased them;

Each institution will thus be able to figure out how big a write-down it must take... and whether it can even stay in business or needs to sell itself to another institution.

There... that's a market! With the restoration of the missing THABI information, the market can reboot, and the catastrophe will be averted. So long as partial-nationalization of the banking industry lasts only long enough to retransparentize the toxic assets, thus allowing the market to begin functioning again, it will be an acceptable, even necessary intervention.

Bush and Paulson have really worked hard to make it difficult for a future president to use this plan as the camel's nose poking its way under the big top; the plan is designed to sunset automatically, allowing the banks to buy back their equity in no longer than three years, but earlier if both they and the incoming administration agree:

“It is profound, and it is something of a shift back to the state,” said Adam S. Posen, an economist at the Peterson Institute for International Economics. “But is this a recasting of capitalism? I think what we’ll see is that the government acts as a silent partner and gets out as soon as it can....”

The package does call for the government investments to be in three-year securities that the banks can repay at any time, when markets settle and conditions improve. “This is clearly a crisis measure in crisis times, but it’s a good thing there is a sunset provision that limits the length of the government’s investment,” said Richard Sylla, an economist and financial historian at the Stern School of Business at New York University.

The historical record of such equity-based interventionism is mixed; on the one hand:

The United States has a culture that celebrates laissez-faire capitalism as the economic ideal, yet the practice strays at times. Over the last century, the federal government has occasionally taken stakes in railways, coal mines and steel mills, and has even taken a controlling interest in banks when it was deemed to be in the national interest.

The corporate wards of the state typically have been returned to private hands after short, sometimes fleeting, stretches under federal stewardship.

But sometimes the shoe is on the other hand:

The traditional American reluctance for government ownership is not shared in other countries. After World War II, several European countries nationalized basic industries like coal, steel and even autos, which typically remained in government hands until the 1980s, when most Western economies began paring back the state’s role in the economy.

After all, we're talking about the federal government; the temptation is always to push far beyond necessity to the tipping point of no return... after which the partial-nationalization becomes permanent, aiming not to restore the market but supplant it.

I will tell you straight: If our next president is Barack H. Obama, then that tipping point is inevitable. Obama's instincts are all European, all towards nationalizing and socializing everything from banking to medical care to taxes; he proclaims over and over again that he will reduce income taxes for "95% of the American people"... knowing that 40% of them don't pay a dime of income tax.

That means at least a third of those whose "taxes" are "lowered" will instead get an annual check from the federal government -- a welfare scheme that will end up, ten years from now, costing more than one trillion dollars per year, according to the Tax Policy Institute; four times what ordinary cash-welfare would cost!

Obama is socialism, socialism is the One. If he is president, he will move heaven and high water to permanize all this federalization, wrenching America away from the Capitalism he hates and cannot understand (and has never, in his entire career, had to deal with) -- it's inevitable. But it's not inevitable that he will win.

We don't know for sure that a John S. McCain administration will know when to say "enough!" -- though that is strongly hinted by his newest economic plan to guarantee all deposits for their full worth, not just $250,000... but only for six months. Whether that's the perfect duration or just a convenient number, it indicates that he is thinking temporary; unlike Obama, all of whose proscriptions and prescriptions are permanent, transformative changes to American society and economy, away from Capitalism and towards socialism.

A "crisis," properly defined, is when the world holds its breath, and nobody really knows what will be. In that sense, we are truly at a crisis, a crossroads between freedom and socialism; we're riding a fast horse that has got the bit in its teeth, and none of us knows which way he shall finally turn his steps.

It is time we started yanking on those reins and leaning hard in the right direction. Now is not the time to close our eyes and abandon ourselves to our fate, to concede the game in the eighth inning. So let's all put on our manly gowns, gird our loins, and pull up our socks: The game ain't over until the last fat lady is hung.

September 30, 2008

The Pearlstein Option Reconsidered

Congressional Corruption
, Econ. 101
, Toxic Jackassets

Hatched by Dafydd

Clearly, we need a new proposal for the credit catastrophe... a proposal that is both workable and passable in the current 110th Congress (the 111th will almost certainly be worse). But allow me to start by looking at one that is obviously un-workable and un-passable.

Read this war statement by Rep. Michelle Bachmann (R-MN, 100%) "explaining" her Nay vote on the Paulson rescue plan; she first exults in her triumph, then enunciates her putatively new proposal. The statement was quoted rather approvingly by John Hinderaker as a good example of the "conservative case" that could be made against the plan:

Today marks an historic moment for America as a solid bipartisan majority of Congress rejected the fatally flawed Paulson Plan. Standing shoulder to shoulder with taxpayers, we declared that we can do better.

As I’ve stated previously, this plan was rushed, unworkable, and short-sighted. A majority of House Republicans have parted ways with President Bush on this plan and we demand that alternative proposals be put on the table. There is universal agreement that this plan was bad, but its supporters claimed it was the only option. There were alternatives available, but Speaker Pelosi and the Administration chose to ignore them and used every parliamentary trick in the book to stifle debate. Now, they will have to listen to the voices of American taxpayers who refuse to open their checkbooks to Wall Street to write a $700 billion check with no strings attached.

I support a plan that would have Wall Street bail itself out, not hardworking taxpayers, by requiring institutions to insure troublesome assets that are causing today’s credit crunch. It would suspend mark-to-market accounting, which forces companies to take losses on artificially devalued assets on an artificial timetable, to give investors more confidence.

The plan I support would break up Fannie Mae and Freddie Mac -- government sponsored enterprises that are at the heart of this crisis -- so that the encumbered taxpayer no longer backs them -- implicitly or explicitly -- and so that they do not artificially grow larger than the market will allow. We cannot pass legislation that sets America up for a Groundhog Day reprise of this mess and that means changing the problem at its core - the GSEs.

Furthermore, the plan I support suspends capital-punishing tax rates to bring more capital into the U.S. markets rather than our foreign competitors. And, the plan ensures the Federal Reserve’s attention is focused on long-term price stability rather than short term economic growth. Finally, it requires the US Treasury to write rules keeping executives who made the risky decisions from personally profiting from them with excessive compensation or golden parachutes all at the expense of taxpayers. We can't have a market that only condones risky behavior. The balance between risk and reward is an important part of the free market.

My colleagues and I stand ready and willing to negotiate with any parties on a plan that will help stabilize our financial markets and relieve the liquidity crisis without exposing taxpayers to a $700 billion bailout debacle.

What is wrong with this picture? Two things:

First of all, in the first blue-highlighted passage, she falsely -- even mendaciously -- caracatures the Paulson plan as a bid to "open [taxpayer] checkbooks to Wall Street to write a $700 billion check with no strings attached."

This is demagogy, pure and simple; it's as bad as Squeaker of the House Nancy Pelosi's (D-Haight-Ashbury, 93%) "history lesson" on the Bizarro-world origins of the crisis in the "unregulated, anything goes" economic policy of the Bush-McCain administration.

Bachmann knows better; she knows that nobody is writing a check to "Wall Street" (is that what Paulson scribbles on the "pay to the order of" line?); that we would in fact be buying securities that are underpinned, at their core, by real property; that the initial cost would be much less than $700 billion; and that the most likely outcome is that those securities would rise in value, so we would make back much of what we spent... and maybe even make a profit.

(We know that House Republicans understand this, else why would they have fought so hard to get a provision ensuring that all "profits" would go to pay down the federal debt?)

But apart from the libelous description of the rejected plan, there is another problem with Bachmann's statement: The centerpiece of Bachmann's own alternative is the same insurance-only option Democrats already rejected.

Why would the Democrats make an abrupt about-face and support it now? After deliberately (most now agree) killing the plan in the first place, does anybody honestly believe that they will now do everything in their power to give the Republicans a huge, huge victory -- right before the election?

The insurance option was never very well explained, and I for one cannot fathom how anyone could think that it, all by itself, would inject enough liquidity to unfreeze the credit market. For one reason, it requires massive insurance premiums to be paid on very, very insecure securities by the same firms that have no capital to pay anything. That's the whole problem... they have no liquidity, and they cannot borrow any money.

What are we supposed to do -- lend them the money to pay for the insurance premiums we charge them? Isn't that a lot closer to "opening taxpayer checkbooks to Wall Street" than the plan they rejected?

It is surreal to offer as a "plan" for resolving a congressional impasse the very provision the other side has already declared a deal-killer. It is absurdist to pretend that this time, everything will be different. Why -- does she think Democrats are now contrite? And it is breathtakingly hypocritical to reject a plan on the grounds that it constitutes writing a check to Wall Street... and then offer in its place a plan that constitutes writing a check to Wall Street.

If there were other new ideas in her "plan" besides the insurance option, something that Democrats had not already emphatically rejected, it might be a good basis to begin negotiation on a compromise. Here are the other ideas she proposes; see if any strikes you as either original or able to resolve the current crisis in any reasonable period of time (that is, before the axe rolls):

Suspend (why not eliminate entirely?) "mark to market" accounting, which forces even those firms that have no intention of selling a security nevertheless to revalue it everytime some other panicked or desperate institution dumps it below the current price -- thus devaluing the reserves of even healthy financial institutions, holding them hostage to the sickest.

This is a good idea -- but not only was it already in the previous bill she voted against, it can only help somewhat... and almost by definition, only helps those institutions that are the healthiest anyway. We need a way to prevent hundreds of unhealthy firms from going belly-up right now.

"Break up" Fannie and Freddie "so that the encumbered taxpayer no longer backs them -- implicitly or explicitly."

I have no idea what she means here: just remove their status as government sponsored enterprises (GSEs), so they become private institutions instead? Or forcibly dismantle them?

While that takes the taxpayer off the hook for propping them up, which is a worthy long-term reform, how does that make either more solvent right now? Wouldn't both Fannie Mae and Freddie Mac then immediately collapse, forcing them to flood the market with more than a trillion dollars (!) of currently toxic, illiquid instruments?

Temporarily suspend the capital-gains tax.

Again, a wonderful idea for the long-term (but let's make it a permanent elimination)... but how does this help now? Does Rep. Bachmann actually think that those firms currently in danger of sinking under the waves are worried about being taxed on some huge capital gain? In fact, as we discussed earlier, suspending the tax removes the incentive for firms to write off bad debts for tax purposes, pushing them towards bankruptcy instead.

Prevent "executives who made the risky decisions from personally profiting from them with excessive compensation or golden parachutes all at the expense of taxpayers."

An interesting argument to make from a congresswoman who goes on, two sentences later, to extol the "free market!" But again, the Democrats are foresquare behind this -- and it would have no short-term impact whatsoever on frozen credit.

[Ensuring] the Federal Reserve’s attention is focused on long-term price stability rather than short term economic growth.

This isn't a proposal; it's a description of the result that Bachmann hopes will accrue from the other elements of the plan. Congress cannot order the Fed to focus on one thing or another and expect to be obeyed:

Owen Glendower: I can call spirits from the vasty deep.

Hotspur: Why, so can I, or so can any man. But will they come when you do call for them?

Shakespeare, Henry IV, Part 1, act 3

What we need is a plan that is both workable -- that is, it would actually help resolve the present credit crisis, not simply a grab-bag of great ideas for making the system better far in the future -- and also passable... something both conservatives and liberals can back. To propose something that is neither is the pinacle of irresponsibility (and electoral stupidity).

I believe several points are imperative; for workability:

Such a compromise plan must give a gigantic incentive for somebody with enough liquidity to take the toxics off the backs of the struggling financial institutions before they all collapse, taking the larger economy with them.

This "somebody" must be able to make them thoroughly transparent, to give the market a chance to revalue them, allowing subsequent sale.

Thus, Mr. Somebody must be able to compel compliance by the former owners in investigating the history of the security.

These three requirements narrow that "whoever" down to some branch of the administration or a proxy that holds the same powers, in my opinion; in other words, this program must be administered by the Treasury, FDIC, the SEC, some other regulatory body, or a corporation administered by one of the above and granted pass-through authority by Congress. Nobody else has the trust, the ready capital, and the regulatory power to make it work.

This doesn't mean that private capital cannot compete with the government for those securities... so long as, in the end, financial institutions are compelled to cooperate with some entity to detoxify their frozen assets and get the credit market moving again.

And for passability through Congress:

The plan cannot be something already rejected by one or the other side as a "deal killer." (Liberal Democrats cannot ram through a Pelosi dream-list -- at least not for four months -- because (a) the Senate would filibuster it, and (b) the president would veto it.)

Yet it must resolve the central problem stopping House conservatives like Michelle Bachmann from supporting it: putting taxpayers at risk for the huge price tag of what they have dubbed a giveaway to Wall Street.

In an earlier post here, we briefly mentioned an intriguing suggestion, the "Pearlstein Option":

There are some other proposals floating about. Steven Pearlstein in the Washington Post has a very interesting one... Treasury sets up a resolution corporation (as per Paulson-Bernanke); but then instead of buying the illiquid securities with cash, they swap them for preferred stock in the new resolution corporation itself:

My own suggestion would be to structure the rescue around a new government-owned corporation that would be capitalized, initially, with $100 billion in taxpayer funds. The company would use auctions or other mechanisms to buy the troubled securities from banks and other regulated institutions, but instead of paying for them in cash, the government would swap them for an equal number of preferred shares in the new company. (Preferred shares are something of a cross between a bond and common stock.) Those preferred shares would pay a government-guaranteed dividend and could be redeemed by the government at any time. But they could also be used by banks to augment the capital they are required to maintain by regulators.

The beauty of this arrangement is that, rather than protecting taxpayers by having the government take an ownership stake in hundreds of privately owned banks, it would be the banks that would own a stake of the government's rescue vehicle. The government would suffer the first $100 billion in losses from buying and selling the asset-backed securities, but any further losses would be borne by the other shareholders. And should the rescue effort actually wind up making a profit, then the banks would share in that as well.

I believe this could be the basis of a new compromise (sorry, more bullets incoming):

It would remove the risk from taxpayers and put it back on Wall Street institutions who accept the preferred stock; the only money spent would be the initial capitalization of the resolution corporation, and perhaps some later recapitalization in the early phases (probably less than the $85 billion required by the takeover of AIG... let alone if, say, Bank of Amerca were to go under).

Nevertheless, by allowing those institutions to count such preferred stock as reserves against whatever they have leveraged, it removes the pressure to sell, sell, sell to get their reserve-to-debt ratio down below the legal minimum.

Since no significant taxpayer money would be going directly to failed financial institutions, there is no way that any rational voter could consider this a "bailout" of Wall Street.

The resolution corporation (fully government-owned, not one of those pesky GSEs) would have the legal authority to compel cooperation by former security owners, thus allowing them to create a paper trail of each security. This will make it possible for the market to "reset" those securities by auctioning them off -- generally for much more than they paid for them.

But because even a government-owned corporation is still a corporation, not the U.S. Treasury itself, other institutions should be allowed to bid against it to buy securities. This creates market forces at both ends, buying the illiquid asset and reselling it.

Assuming all goes more or less as planned, the resolution corporation will make a profit... thus giving a big incentive to institutions to participate, since the value of their preferred shares in the resolution corporation will rise, giving them even more reserves.

The Democrats evidently had no problem with allowing the federal insurance idea as an option, not the entire plan, since it was an option in the last bill; I presume this means they'll allow it as an option again.

I hope this idea is at least brought up; I'm sure that a sizeable minority of Republicans now regrets its Nay vote and are looking for an excuse to change it; and I further suspect the majority of conservative Naysayers is quite willing to consider voting Aye -- for a less statist, more free-market proposal such as the Pearlstein Option.

But whatever we do, we need to do something quick. This isn't just the "do something!" disease; we really are on the brink of catastrophe. You know I'm not given to Cassandra-like dire warnings of pending doom... but let's all remember that Cassandra was right, and Troy did indeed fall.

Like a blinking VCR clock, even a prophet of doom can be right once a day.

September 28, 2008

Done Deal - at Least, Very Likely Done

Congressional Corruption
, Econ. 101
, Toxic Jackassets

Hatched by Dafydd

It appears that John S. McCain's intervention has borne fruit: All of the major players -- the White House, the Senate and House Democrats, the Senate Republicans, and now even the House Republicans (HRs) -- appear to have signed off on a credit-rescue deal tonight.

As we predicted, it is basically the original deal with some of the HRs' proposals rolled in... notably the insurance option, which would be one of the choices that Secretary Henry Paulson has at his disposal and is required to set up and at least attempt before buying the toxic assets on behalf of the government:

At the insistence of House Republicans, who threatened to sidetrack negotiations at midweek, the insurance provision was added as an alternative to having the government buy distressed securities. House Republicans say it will require less taxpayer spending for the bailout.

But the Treasury Department has said the insurance provision would not pump enough money into the financial sector to make credit sufficiently available. The department would decide how to structure the insurance provisions, said Sen. Kent Conrad, D-N.D., one of the negotiators.

This story doesn't quote any House Republicans directly; but I don't think they would stay silent if they were once again being rolled by the other players. Still, the AP story is cautious -- having been fooled once by Squeaker of the House Nancy Pelosi (D-Haight-Ashbury, 93%) and Senate Majority Leader Harry "Pinky" Reid (D-Caesar's Palace, 85%):

It was not immediately clear how many House Republicans might vote for the measure. With the election five weeks away, Democrats have said they would not push a plan that appeared sharply partisan in nature.

(That is, "Fool me once, shame on you; fool me 527 times in a row, and you can call me an Obamaton.")

The New York Times story did manage to corral Rep. Roy Blunt (R-MO, 96%), lead negotiator for the HRs, but he was in a "show-me" mood:

Representative Roy Blunt of Missouri, the chief negotiator for House Republicans, who have been among the most reluctant to support the plan, expressed some satisfaction but did not commit his members’ support.

“We need to look and see where we are on paper tomorrow,” Mr. Blunt said. “We have been talking about how we can make these things work in a way that our conference can come together.”

Some other concessions to the free market and conservative principles were obtained by Blunt, McCain, and the HRs:

The salary and bonus caps would only apply to "fired executives of financial firms, and executives of firms that go bankrupt," as AP puts it, not to every executive at every company that sells distressed securities to the federal government, as Democrats originally demanded.

The "equity interest" that the Democrats wanted in all firms that sell assets to the resolution corporation will be limited to only some of them, but I cannot discover the criteria that will determine which do and do not have to give up some stock to the Treasury-created corporation.

The Democrats had demanded that 20% of any profits that the feds might make on the deal, as they auction off value-added securities in an improved market, be ploughed into affordable housing -- which is what got us into this mess in the first place; but the HRs appear to have killed that provision.

Democrats also have given up on their scheme to allow bankruptcy judges to unilaterally alter the terms of first mortgages in bankruptcy proceedings; instead, the Treasury will have the authority to attempt to renegotiate mortgage terms if that would reduce the liability facing the government by reducing the risk of default or even foreclosure. That is, only when such renegotiation is good for the United States... not whenever it's advantageous to the over-extended borrower (buying a $400,000 dream house when he really could only afford a $200,000 fixer-upper).

But for the timely intervention of John McCain, no one would have talked to the House Republicans, and none of these concessions would have been made; therefore, the deal would never have gone through. McCain has kept in constant contact with the negotiators, relaying information back and forth, pushing for the necessary compromises, and selling the HRs on the plan.

Barack H. Obama, meanwhile, has also been "active," as the Times insists:

Early in the day, the two presidential nominees were active from the sidelines. Mr. McCain telephoned Congressional Republicans to sound them out, and Mr. Obama got regular updates by phone from Mr. Paulson and top lawmakers.

Evidently, the word "active" in Obama's case means standing anxiously by the phone, waiting for a call to bring him up to speed, so he won't look ridiculous.

Finally, I find this tidbit to be most illuminating:

While Congressional Republicans sent only their chief negotiators, Mr. Blunt and Senator Judd Gregg of New Hampshire, at least nine Democrats with competing priorities piled into the meeting, surprising the Republicans but apparently not unsettling them.

It fills my heart with patriotic joy to see the Democratic Party put aside its petty, internecine differences to resolve a true national crisis.

September 26, 2008

The Roads Must Roll, Along With a Few Heads - slight UPDATE

Here is the bailout problem in a nutbag. There was indeed a deal before John S. McCain arrived... a completely bicameral deal between House Democrats -- and Senate Democrats. The deal also included (evidently) the White House; and the Senate Republican conference climbed aboard the bandwagon.

The outlines of the deal were that President George W. Bush gets the Paulson-Bernanke emergency rescue plan -- and the Democrats extort a number of their domestic welfare programs:

Long-term extension of unemployment benefits, so that fewer people will go back to work;

A "housing trust fund" that would funnel taxpayer money to ACORN and other radical groups;

Salary caps on everyone who makes more money than members of Congress;

A secret, back-door restoration of the ban on shale-oil development, which Majority Leader Harry "Pinky" Reid (D-Caesar's Palace, 85%) tried to sneak into the rescue bill;

Fascistic government ownership of the banks, and so forth.

Of course, if you pore over the list above of participants in this deal, you will of course notice one missing piece: House Republicans. The House Republican conference is consistently more conservative, free-market, and even libertarian than any of the other four groups... and not surprisingly, they completely rejected this deal.

But nobody was speaking for the House Republicans; in fact, it appears that nobody was speaking to them, either. So despite the fact that McCain is a senator, not a representative, he nevertheless realized that without the House Republicans (HRs, from now on), no deal would ever be inked. Even though Democrats have a majority in the House (and no filibuster rule), they refused to pass legislation without the "cover" of a majority of the HRs along for the ride. (Which itself is a telling sign: The Democrats did not want to "own" the package.)

Thus, McCain thought it important enough to temporarily (for a few days) suspend his campaign, fly back to D.C. -- which is where his actual job is (and Barack H. Obama's too, by the way) -- and see if he could restart the dialog between the HRs and Everybody Else.

I believe every element of the House plan is worth some consideration in itself, and several would probably help the situation; but I do not believe that even all of them put together would actually resolve the illiquidity of the mortgage markets.

The core of their plan is to get the financial institutions to buy the toxic assets themselves by federally insuring them:

Under the alternative Republican plan, the government would set up an expanded insurance system, financed by the banks, that would rescue individual home mortgages. The government would not have to buy up the toxic mortgage-backed assets that are weighing down financial institutions.

They've also proposed a two-year suspension of the capital-gains tax -- which might actually be counterproductive in the short-term: These toxic assets are of course worth much less than the institutions paid for them; which means if they sell them, they would actually have a capital loss, not gain. Under the current system, they can claim a deduction for that loss; but if we suspend the cap-gains tax for two years, the financial institutions won't be able to deduct their losses.

In the long run, reducing or even eliminating capital-gains tax is a great idea. But it's not going to help in the present crisis.

In the end, I suspect the HRs will relent and compromise: They will accept the guts of the Paulson-Bernanke proposal in exchange for some significant trimming of the Democrats' grab-bag of socialist-populist goodies, particularly including the "equity stake" that the federal government would take in the affected institutions; my reading of the tea leaves tells me this is something that Senate Republicans love but of which House Republicans are very, very skeptical, for the same reasons I enunciated yesterday.

There is already some movement towards a compromise:

Cantor said that some of the "exotic sliced and diced" mortgage-backed securities at issue for the financial institutions are of such little value -- because the underlying mortgages are already in foreclosure -- that using the Republicans' preferred approach of federally insuring them is pointless. "So you've got to go with Paulson's model," Cantor said today, endorsing the federal purchase of those securities to clean up the books for financial firms in distress.

In exchange, Cantor said he is seeking some sort of assurance that that the Treasury secretary would be allowed to create an insurance program for the other mortgages, charging premiums to the firms holding securities tied to those mortgages.

There are some other proposals floating about. Steven Pearlstein in the Washington Post has a very interesting one... Treasury sets up a resolution corporation (as per Paulson-Bernanke); but then instead of buying the illiquid securities with cash, they swap them for preferred stock in the new resolution corporation itself:

My own suggestion would be to structure the rescue around a new government-owned corporation that would be capitalized, initially, with $100 billion in taxpayer funds. The company would use auctions or other mechanisms to buy the troubled securities from banks and other regulated institutions, but instead of paying for them in cash, the government would swap them for an equal number of preferred shares in the new company. (Preferred shares are something of a cross between a bond and common stock.) Those preferred shares would pay a government-guaranteed dividend and could be redeemed by the government at any time. But they could also be used by banks to augment the capital they are required to maintain by regulators.

The beauty of this arrangement is that, rather than protecting taxpayers by having the government take an ownership stake in hundreds of privately owned banks, it would be the banks that would own a stake of the government's rescue vehicle. The government would suffer the first $100 billion in losses from buying and selling the asset-backed securities, but any further losses would be borne by the other shareholders. And should the rescue effort actually wind up making a profit, then the banks would share in that as well.

I don't believe this would have happened without John McCain's presence: It took the support of a man so universally respected on the Republican side, even by those Republicans who frequently oppose him -- ironically, the very same House Republican conservatives whose cause he champions today -- to get the corrupt Democrats and the blowhard Senate Republicans to pay their House brethren any attention at all.

My guess is that many of the HRs' proposals (and several proposals of other critics, such as Pearlstein's "preferred shares" swap) will be rolled into the plan; much of the Democratic garbage will be stripped out; and the guts of the Paulson-Bernanke plan will be enacted with near universal support in both the House and Senate, to be signed by the president into law.

The liquidity crisis will be averted; companies will stop going under; the stock market will rebound (it hasn't dropped all that much, really); the Democrats will be exposed (well, by us, at least) as the venal rats who caused the problem in the first place; President Bush will seem a bit more presidential; John McCain will seem a lot more presidential.

The biggest loser will be, I think, Barack H. Obama, as more and more voters start to ask -- "Who is this guy anyway?"

And he'll lose tonight's debate, too.

UPDATE:

These two videos are making the rounds; they fit so perfectly here, I just have to include them.

First, here is the blunt Rep. Roy Blunt (R-MO, 96%), official negotiator for the HRs in the Big Blowout, discoursing on how helpful John S. McCain has been during the negotiations, appointing himself Speaker to Animals... that is, guardian angel for the House Republicans. Watch this one first...

Now, here is the "same" video -- as creatively edited by the Barack H. Obama campaign, or some surrogate. Notice a few very subtle excisions, almost too small even to notice:

Team Obama is pointing to the truncated video to claim that even Roy Blunt agrees that McCain has been nothing but a roadblock, toppling a done deal and plunging America into a dark night of the financial soul.

Want to know just how corrupt, mendacious, and dishonorable is the campaign by the One We Have Been Waiting For, campaigning by what we call "Chicago rules?" That's how.

If in fact they have nothing to do with this disgraceful knife-job on Blunt's praise, there is a simple way to show it: The campaign can denounce this bearing of false witness. Let's see if any such denunciation forthcomes.

September 22, 2008

Democrats Try to Hijack the So-Called "Bailout"

Congressional Corruption
, Toxic Jackassets

Hatched by Dafydd

Republicans see the collapse of the mortgage market as a potential catastrophe that requires emergency measures... but an aberration caused by government intrusion into the market, not an indictment of capitalism and free markets.

Democrats see it as proof positive that capitalism has been proven to be a fad that will soon pass away, like pet rocks... and a golden opportunity to reintroduce failed liberal fascist economic policies straight out of the platforms of Woodrow Wilson, Franklin Roosevelt, and Jimmy Carter.

Which George W. Bush will show up... the veto-wielding Bush with a spine that we've seen in Democratic spending legislation after the 2006 elections -- or the wimpy, appeasing Bush that we've seen in legislation on racial preferences, Israeli-Palestinian "negotiations," and Republican spending prior to the 2006 elections? The choice will spell the difference between a small-footprint intervention or a massive repudiation of decades of progress on free-market economics.

But first, let's again talk about how we got into this mess.

Subprime mortgages, securitization, and toxic assets

This is the crux of the crisis: Back in the cretaceous period, when a bank or S&L issued a mortgage, it held that mortgage until the borrower paid it off. But in the contemporary era, what starts out as a mortgage is typically bundled with other mortgages into a "mortgage-backed security" (MBS) -- essentially bonds that can be traded on the open market. Bizarrely, in the process, bad debt automagically becomes good investment.

How are MBSs created? Let me quote from an excellent sumary in a newsletter by John Mauldin (free registration required):

Let's jump back 18 months. I spent several letters going over how subprime mortgages were sold and then securitized. Let's quickly review. Huge Investment Bank (HIB) would encourage mortgage banks all over the country to make home loans, often providing the capital, and then HIB would purchase these loans and package them into large securities called Residential Mortgage Backed Securities or RMBS. They would take loans from different mortgage banks and different regions. They generally grouped the loans together as to their initial quality as in prime mortgages, ALT-A and the now infamous subprime mortgages. They also grouped together second lien loans, which were the loans generally made to get 100% financing or cash-out financing as home owners borrowed against the equity in their homes.

Typically, a RMBS would be sliced into anywhere from 5 to 15 different pieces called tranches. They would go to the ratings agencies, who would give them a series of ratings on the various tranches, and who actually had a hand in saying what the size of each tranche could be. The top or senior level tranche had the rights to get paid back first in the event there was a problem with some of the underlying loans. That tranche was typically rated AAA. Then the next tranche would be rated AA and so on down to junk level. The lowest level was called the equity level, and this lowest level would take the first losses. For that risk, they also got any residual funds if everyone paid. The lower levels paid very high yields for the risk they took.

Then, since it was hard to sell some of the lower levels of these securities, HIB would take a lot of the lower level tranches and put them into another security called a Collateralized Debt Obligation or CDO. And yes, they sliced them up into tranches and went to the rating agencies and got them rated. The highest tranche was typically again AAA. Through the alchemy of finance, HIB took subprime mortgages and turned 96% (give or take a few points depending on the CDO) of them into AAA bonds. At the time, I compared it with taking nuclear waste and turning it into gold. Clever trick when you can do it, and everyone, from mortgage broker to investment bankers was paid handsomely to dance at the party.

So what started as mortgages -- ranging from very secure prime mortgages, which are doing fine, to lousy subprime mortgages for too much money to borrowers who really didn't have either the credit history or income to justify such loans, many of which are currently in default 60 days or more -- were, by the magic of "securitization," turned into bond-like securities; and in the process, many of the bad and even defaulted loans were transmaugrified into AAA-rated investments.

The banks and other financial institutions that securitized mortgages (and resecuritized already securitized MBSs) would make their nut by skimming some percent, typically fifty basis points (0.5%), off the loan rate; thus, if they began with a package of mortgages at 6.5% (they tried to bundle like with like), they would securitize them into an MBS that paid 6%, keeping the difference -- and hoping there would be few enough defaults that the mortgages would produce more than 6% net.

What happens when loans are defaulted is very complicated and not really germane to this post; they created different tiers, or "tranches," with different ratings -- AAA down to junk -- for different prices, that distributed the losses from worst tranch up to best. Not important here.

But defaults, of course, are where the whole pyramid scheme broke down. While housing prices continued to rise, everybody was happy and there were few defaults. But starting a couple of years ago, when the housing bubble burst and the mortgage default rate shot up, a bunch of banks found themselves holding very insecure securities, losing money hand over teakettle. The crash began among the lenders and spread to secondary markets (the MBSs and CDOs) and even tertiary markets (insurance underwriters like AIG). In short order, institutions all over the world found themselves holding pieces of paper whose value was impossible to determine -- which are referred to as toxic assets.

Toxic assets are illiquid, meaning they cannot be bought or sold because nobody knows how much to offer for them; they are frozen. If you hang onto them, they might regain some value later... or they could disappear completely. Worse, illiquid securities see their ratings drop; and current law forbids some types of funds from holding anything but AAAs... which means they may be forced by law to sell -- but unable to sell because of illiquidity!

Not only that, but current law also requires that such securities be "marked to market," meaning they must be valued at the last price offered by some institution that was desperate to sell -- because of the law in the previous paragraph. Thus, even institutions that didn't have to sell their toxic assets had to reprice them; this meant that a number of financial institutions suddenly did not have sufficient reserves for the amount of loans or leveraging they had out. That meant they needed to get hard cash and fast... which meant they would have to panic-sell a bunch of securities, precipitating a new round of re-rating and re-valuating.

Eventually, nobody had a clue what anything was worth anymore; and nearly every financial institution in the world, it seems, was involved up to the fourth cervical vertebra in this mess.

It was that uncertainty that caused the mortgage market to collapse. It's like trying to buy a car when all you can see is a grainy photo in a newspaper: You can't test-drive it, inspect it, or even kick the tires. You don't even know whether it contains an engine... how can you possibly make any kind of offer whatsoever?

Worse yet, the seller has never seen the car either, and he knows no more about it than you!

So what is to be done? Obviously, since the problem is the inability to set a value for these instruments, which makes them impossible to buy or sell (illiquid), the solution is to find a way to value them. Enter the Paulson-Bernanke emergency rescue plan.

Treasury presses the reset button

As proposed by Secretary of the Treasury Henry Paulson and Chairman of the Federal Reserve Ben Bernanke, the putative "$700 billion" "bailout" is actually neither: It will neither cost that much, nor will it bail out those financial institutions that wrote bad loans for people they knew were not likely to be able to pay them off.

As I understand it, here is the basic plan. Note that I'm drawing this from many sources, it's not yet written in stone -- or even in ink -- and I can't give you sources. If you want more information, you're on your own! But here is what I've been able to glean:

The Treasury is given authority to spend up to $700 billion (outstanding at any particular moment) to buy MBSs, CDOs, and related instruments that have become "illiquid." These "toxic assets" will be purchased from their current owners at a huge discount... meaning the banks and other investors who purchased these pigs in pokes will, in fact, take a significant financial hit... they're not being "bailed out."

So the Treasury can buy up these toxic assets; what do they do with them?

I believe the plan (which has not yet been formalized in legislation) is to create a Treasury owned and managed resolution corporation that will take ownership of these toxic assets. Analysts will then pore through each MBS, determining the status of all the underlying mortgages and making a report publicly available. This will make the opaque assets completely transparent. All the financial fundamentals will be visible, so analysts at private companies can examine all of the securities and decide how much they would pay for each.

The resolution corporation will then auction off each of the the now-transparent MBSs, selling it to the highest bidder; that very action allows the market to reset the value of the security.

That is why I characterize this rescue operation as "pressing the reset button."

Once some corporation has examined the fundamentals of the security and offered the winning bid for it, the MBS becomes (by definition) liquid; it is no longer a toxic asset. Its value has been reset... and it can go up or down after that point based upon subsequent, well-understood events (defaults, repayments, prepayments) in the underlying mortgages and reevaluations based upon other, market-based criteria. In other words, it becomes just like a mutual fund.

The crisis was the inability to value MBSs; the solution is to reset their values. The beauty of the Paulson-Bernanke plan is that this resetting is done by the free market, not by government decree.

Finally, note this point:

When the Treasury-owned resolution corporation auctions off the now-transparent MBSs, it can use that money as income. Since the asset is now much more valuable than before (having been scrubbed into transparency), if it becomes saleable, then it will certainly sell for more than the discounted rate at which the corporation bought it. In other words, the resolution corporation will make a profit on every security it resells -- so the program will not actually cost $700 billion... it may even end up completely in the black.

That's why the Paulson-Bernanke plan is neither a bailout -- the so-called beneficiaries in fact must pay dearly for their folly -- nor massively expensive, since it resells most of the securities it bought, and at a profit. It could still end up costing money, depending on how many of the MBSs end up still toxic even after the complete report (if too many of the underlying mortgages are in default, for example); but the losses won't be anywhere near $700 billion, and they may be less than the profits.

Democrats: fingers in the pie, finger in your eye

But the loyal opposition is not content to use the Paulson-Bernanke emergency mortgage-market rescue plan to rescue the mortgage market from the current emergency; how dull that would be, especially in an election year. Rather, they see America's crisis as their opportunity to enact or re-enact by extortion every awful, failed, thoroughly discredited, socialist-populist scheme they have tried, or always wanted to try, over the past century. Senate Democrats demand:

Contingent stock in every, single company that sells its toxic assets to the resolution corporation; this would give the federal government a degree of ownership of virtually every bank, savings and loan, or other financial institution in the entire country. It is liberal fascism at its purest, and it would lead directly to much greater government control of private capital.

They demand that bankruptcy judges be allowed to rewrite the terms of the underlying mortgages, in order to "provide direct assistance to homeowners caught in the foreclosure crisis"... in other words, to allow people who took out loans much too big for houses they could not afford to nevertheless keep those houses, even though they cannot make the payments. All at the expense of financial institutions that are teetering at the brink as it is.

Democrats demand "limits on the pay of top executives whose firms seek help." That is, Congress would set the salaries and bonuses of executives working at companies that are in serious trouble because of the mortgage meltdown... and that's always worked out so well in the past!

They also have structural demands:

The 44-page Senate proposal, pulled together by Senator Christopher J. Dodd, Democrat of Connecticut and the chairman of the banking committee, would require the Treasury to run the rescue plan through a new "Office of Financial Stability" to be headed by an assistant treasury secretary. It would also establish an "Emergency Oversight Board" to monitor the bailout effort, made up of the Fed Chairman, the chairman of the Federal Deposit Insurance Corporation, the chairman of the Securities and Exchange Commission; and two non-government employees with "financial expertise" in the public and private sectors, one each appointed by the majority and minority leadership in Congress.

In addition, the Senate proposal would require monthly reports to Congress, rather than the biannual reports that would be required under the Bush administration’s proposal.

This sounds like an invitation to micromanagement -- and unless I miss my guess, the "Emergency Oversight Board" will somehow end up stuffed with former members of the Clinton administration and/or Barack H. Obama's campaign, like Franklin Delano Raines, James Johnson, and Jamie Gorelick... the same people who ran Fannie Mae and Freddie Mac into the ground and ran many of the very multinationals that offered subprime loans, hedge-funds and other derivatives, or that insured these toxic assets, thus creating the crisis in the first place.

While former Clintonista (and now Charlie "Tax Ducker" Rangel's lawyer) wants the Democrats to go even further:

Barack Obama has tried to run as a unifying centrist. Now it may be time for him to clear the fog and talk, walk and sound like a true FDR liberal -- reminding the American people that at times like this, the government is a friend, not an enemy, contrary to conservative theology. Indeed, now may be the time for him and the Democratic Congress -- urged on as recently as Thursday by Treasury Secretary Henry Paulson -- to take the next 30 days to enact something reminiscent of FDR's first 100 days. It should be more than just a $700 billion bailout. It should also include billions to help homeowners avoid foreclosure, to assist the auto industry, to upgrade the nation's infrastructure, and to spur development of alternative energy sources.

One can always trust Democrats to find a way, in any crisis, to throw gasoline at the bull.

President Bush (and the upcoming President John S. McCain) must remain stalwart and demand an up or down vote on a clean version of the Paulson-Bernanke rescue plan... no add-in spending, no wage and price controls or upgrading the nation's infrastructure, and specifically, no damned earmarks.

Anything less than this standard of rectitude and disinterested statesmanship would be an economic betrayal of America... and must lead to electoral ruin for any party which puts immediate self-gratification ahead of national economic survival.

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